Medicare beneficiaries can choose to receive benefits either through the original Medicare fee-for-service (FFS) program or a Medicare managed care plan, subject to the availability of a plan in the beneficiary's local area. Beneficiaries choose managed care plans over FFS because: (i) plans provide a meaningful prescription drug benefit, (ii) plans offer prevention and wellness benefits similar to those provided by employers, (iii) beneficiaries in managed care plans do not need to spend over $1500 per year on a separate Medicare Supplement policy, and (iv) managed care plans involve less paperwork, particularly since beneficiaries do not file claims. FFS is the passive choice and Beneficiaries stay with FFS primarily to preserve their choice of physician, for geographic flexibility, and distrust over having their care ”managed” by an HMO.

Medicare managed care plans, also known as “coordinated care” plans, have been available since the early 1980s. The Balanced Budget Act of 1997 authorized the Medicare+Choice (M+C) program, which expanded the types of Medicare coordinated care plans. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 renames the Medicare+Choice program “Medicare Advantage” (MA), and improves and modernizes the Medicare managed care program through increasing payments to health plans and authorizing broader managed care benefits to beneficiaries.

Medicare managed care plans can be structured as Health Maintenance Organizations (HMOs), Preferred Provider Organizations (PPOs), and Provider Sponsored Organizations (PSOs). A Medicare HMO is a state licensed managed care plan that is certified by CMS to provide a Medicare benefit plan to its members. A PSO is a federally authorized, community-based Medicare-only managed care entity similar to an HMO, but owned and governed by the physicians and/or other providers. A Medicare PPO is a contracted network that provides preferred provider pricing to Medicare beneficiaries, but with less coordination of care. The regional PPO is a new Medicare Advantage plan option scheduled for introduction in 2006.

Both the Medicare HMO and PSO contract directly with the federal government through CMS to enroll eligible Medicare beneficiaries in the plan's service area (usually a county). CMS pays the plan a set monthly premium in exchange for the plan providing all the regular Medicare covered services the beneficiary requires plus additional, optional benefits. The HMO or PSO is responsible for constructing the approved benefit plan, enrolling the member-patients, providing a medical treatment delivery network, managing medical utilization, paying claims, delivering member services, managing the financial risk and reporting to CMS and state insurance regulators. The plan makes a profit by providing care and administering the benefits program for less than the CMS payment. This is similar to how health insurers operate, except the “premium” for Medicare members is “fixed” and not subject to market price competition. Payment of Medicare “premium” to HMOs and PSOs is backed by the full faith and credit of the federal government.